Don't Get Whipsawed

By

Alan Abelson

July 10, 2010 12:01 a.m. ET

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"DEATH CROSS." THAT DOESN'T, as you well might infer, describe one of the great pedestrian pastimes in these parts—trying to dash across almost any street in midtown Manhattan against traffic. Rather, as alluded to last week by our erudite fellow columnist, Mike Santoli, it's an admirably scary title for an indicator that suddenly has become all the rage among wannabe stock-market technicians.

What it actually describes is the crossing of a 50-day moving average below a 200-day moving average of the Standard & Poor's 500 Index. (In case you wondered, both averages are inscribed not on a sacred tablet kept in a secret cave for exclusive perusal by card-carrying technicians, but on plain old chart paper.)

A real honest-to-goodness technician, the best we have ever come across in these many years of toil in the vineyards of capitalism, with whom we had lunch last week, distracted us from serious contemplation of our lobster salad by noting the burst of popularity of the "death cross" and suggested it might be a short-term contrary (in this case, bullish) indicator.

On that score, he related that The Chart Store (www.thechartstore.com) had surveyed all the "death crosses" since 1930 and found that somewhat more than half the time, stocks were higher a month or two later. But even without that reassuring bit of market history, our friend did anticipate a bounce after the vicious whipping stocks have taken in the past two months, climaxed by the pre-July Fourth weekend rout, with the major measures down 13% to 15% from their late April highs. And, sure enough, on Wednesday, we got a boomer of a triple-digit advance, followed by a late sprint on Thursday, after a mostly desultory session, to put some icing on the cake.

After a brief glimpse at his trusty crystal ball (he never leaves home without it), the technician ventured that the rebound might carry for a spell, but most likely would fall short of setting a new yearly high and then peter out, followed by fresh decline. Come the fall, he expects the market might pull itself together in time for a pre-election rally.

All of which he would take as further confirmation that, despite periodic winning streaks, some of them quite spirited, we're still in the grip of a secular bear market that has some years to run. And while many investment pros drool over what they view as relatively low valuations of 12 to 15 times earnings for quality companies, our friend points out that undervalued isn't the same as cheap.

He suggests that a market that hiked price/earnings ratios way up into the stratosphere in 2000 could just as easily go to the opposite extreme, as it did in the early 1980s at the end of the 1968-1982 bear market, when shares of first-rate companies were trading at six to eight times earnings. And while interest rates were much higher than they are now, reflecting rabid inflation, today's extraordinarily low rates reflect a starkly different but equally troublesome problem: deflation.

What our prophetic friend envisions is a vacillating market of wide swings lasting for an extended stretch, similar to that of 1938-1942, bounded roughly by this year's top set in April and the March '09 low. It's the kind of market in which you should take special care not to get carried away by the occasional brisk rallies, lest you get carried out when those rallies fizzle, followed in a flash by the inevitable bouts of vertigo.

SOMETIMES, IT GRIEVES US to say, altruism doesn't pay, as witness the sorrowful plight of Rod and Patti Blagojevich. Rod is the former governor of Illinois who is now on trial for allegedly trying to peddle a Senate seat. He faces a possible 415 years in the hoosegow if found guilty (he might have to serve only 400 if he gets a break from the judge, which would still give him plenty of time to write his memoir).

The tragedy here is that Rod got himself into a financial pickle by doing his best to help our country when its economy was floundering back in 2002. For the next six years, he and the missus shelled out $400,000 for nice threads and furs and that sort of thing, using eight or nine credit cards in their feverish determination to do their patriotic best to spur a recovery.

But instead of thanks, or even a decent bid for the Senate seat, Rod wound up a couple of hundred thousand bucks in the hole and charged with racketeering and corruption. And, to make matters worse, a lot of those fancy suits and designer dresses are no longer in style, although Rod may not have to worry about what to wear for the next 400 years.

What made us think of Rod Blagojevich's mournful plight was disclosure by the Federal Reserve that the consumer, who accounts for two-thirds of the economy, isn't playing his customary role of sparkplug. Just the opposite: He cut back his borrowing in May by a formidable $9.1 billion, making it the fourth straight month of contraction (April's reported increase of $954.8 million, it turns out, was slightly exaggerated and duly revised to a drop of $14.9 billion).

Credit-card use (so-called revolving credit) shrank by $7.4 billion, or 10.5%, extending its string of monthly declines to 20. Forced frugality obviously remains very much the byword (and, alas, the anti-buy word) among the dispirited Janes and Joes (even if not among the Rods and Pattis).

With three million folks slated to lose unemployment benefits by the end of this month, and something like five times as many job seekers out there as there are job openings, the mood of the consumer, less than ecstatic in any case, is likely to remain somber and his eagerness to spend constrained.

TO BORROW FROM THE LIVELY LEXICON of Ross Perot, a fearless forecast: Sooner rather than later, Wall Street will launch trading in spy swaps. Following the now-famous exchange of agents between the Russians and the U.S., we foresee a vast and active market in such swaps between Iran and the U.S., the North and South Koreans, India and Pakistan, Israel and Syria, China and Taiwan, Colombia and Venezuela, etc., etc., etc.

Just as the housing bubble was blown out of all proportion to satisfy the Street's insatiable appetite for mortgages with which to structure asset-backed securities, we can anticipate a boom in the spy business fanned by the Street's exploding demand for spies.

The global unemployment problem, including this proud nation's, promises to be significantly alleviated by the worldwide competition to recruit spies (no documentation required). The Big Board, hungry for revenue, would be only too happy to handle the buying and selling of spy swaps, and it would be a natural hunting ground for practitioners of high-frequency and flash trading, who are already skilled in the art of surreptitious activity.

And the really good part is that when, as all bubbles must, the spy-swap bubble bursts, the kindly Fed, we haven't a scintilla of doubt, will be standing by, ready and willing to buy up any badly depreciated (read: worthless) spy-swap-backed assets and cheerfully pay full price.

While we anxiously await the advent of this latest innovative marvel from the people who brought us program trading, collateralized debt obligations and the rest of those wonders of financial engineering that have so enriched our lives, we still must wrestle with such mundane stuff as an economic expansion that barely shuffles along and, as noted above, a grimly reluctant consumer.

In her latest MacroMavens commentary, Stephanie Pomboy, with her trademark spice and flourish, zeroes in on the greatest impediment to the consumer resuming his free-spending ways, namely his towering debt—which we deliberately neglected to include in our little riff on consumer spending, so as to give Stephanie an open field. (Who said journalists have no manners?)

There's no way, she says firmly, that households can seriously deleverage overnight. The task is truly humongous: To return to those halcyon pre-Greenspan days when the ratio of debt to income was about 65% would require, she reckons, debt to decline by $6.3 trillion (or, just as daunting, income to increase by $9 trillion).

That would mean a massive reduction in spending, year in, year out, spread over six to 10 years. But, she sighs, there's virtually zero chance of that happening, if only because the bottom 40% of households spend every last dollar they make—and then some—just to keep their heads above water.

Of the $14 trillion in household debt, she notes, $10.5 trillion is mortgage-related. And, as Stephanie puts it, since stiffing your banker is now "socially acceptable, deleveraging needn't entail the pesky inconvenience of foregoing consumption," and she predicts more homeowners will exploit this opportunity "to accelerate balance-sheet repair."

It's an open question, she feels, as to how much of the burden will be borne by banks (via rising delinquencies) versus the economy (via reduced spending). What is clear is that the low end of the income scale, with transfer payments such as unemployment benefits drying up and credit exceedingly tough to come by, already is feeling the hit.

Stephanie also discerns considerable distress among consumers generally in the astonishing decline in bank deposits, clear evidence they're starting to burn through cash.

Little wonder she remains anything but bullish on the economy or the stock market.

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